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Bubble Risks and Macro Prudential Policy

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Bubble Risks and Macro Prudential Policy 22nd Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies “Building a Financial Structure for a More stable and Equitable Economy” April 17-19, 2013 Bubble Risks And Macro Prudential Policy Frank Veneroso 1 Part I: The Hopeless Past Present And Future State of Regulation 2 Our regulators have been hopeless. Elizabeth Warren reminds us they remain hopeless. 3 Senator Elizabeth Warren, Massachusetts "If you're caught with an ounce of cocaine, chances are good you're going to jail. If it happens repeatedly, you may go to jail for the rest of your life, but evidently, if you launder nearly $1 billion for drug cartels and violate our international sanctions, your company pays a fine and you go home and sleep in your own bed," "How many billions of dollars do you have to launder for drug lords and how many economic sanctions do you have to violate before someone will consider shutting down a financial institution like this?” 4 Why no indictments? Because, Geithner said, they will rattle the markets. Attorney General Holder admits to something similar. 5 U.S. Attorney General Eric Holder, Jr. “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy. And I think that is a function of the fact that some of these institutions have become too large.” 6 In April 2008 Justice told us they knew commodity markets and especially oil were being manipulated. 7 Remarks Prepared for Delivery by Attorney General Michael B. Mukasey on International Organized Crime at the Center for Strategic and International Studies Washington, D.C. Wednesday, April 23, 2008 - 1:30 P.M. 8 Mukasey On Commodities, April 2008 Criminals target energy, financial markets, Mukasey says •Attorney general: International organized crime is a growing threat to U.S. security •Criminals have penetrated portions of the international energy market, Mukasey says •Groups also trying to corrupt financial service providers, he warns WASHINGTON (CNN) -- Attorney General Michael Mukasey warned Wednesday that organized criminal networks have penetrated portions of the international energy market and tried to control energy resources. The first threat we identified was that international organized criminals control significant positions in the global energy and strategic materials markets. They are expanding their holdings in these sectors, which corrupts the normal functioning of these markets and may have a destabilizing effect on U.S. geopolitical interests. In a speech at the Center for Strategic and International Studies in Washington, he said similar efforts have targeted the international financial system by injecting billions of illicit funds to try to corrupt financial service providers. 9 Justice Knew All, Because These Guys Know All. 10 Attorney Mukasey Speech, April 2008 "U.S. intelligence agencies provided "vital input" into the threat analysis that underpinned the strategy, said a U.S. intelligence official authorized to speak to the media.“ 11 If you know commodity markets you know the manipulators Mukasey was referring to. 12 Overview Of The Law Enforcement Strategy To Combat International Organized Crime, April 17, 2008 http://www.justice.gov/ag/speeches/2008/ioc-strategy-public-overview.pdf “International organized criminals do not need to reside in the United States to engage in criminal activities targeting the United States, its interests and its people. With the advent of globalization, the Internet, international banking and modern technologies, international organized criminals can remain in countries that provide them with safe haven from arrest while perpetrating criminal activities targeting the United States and its people. The most powerful international organized crime groups benefit from the symbiotic relationship that their leaders have developed with corrupt public officials and business tycoons. The three elements combine forces to form strategic alliances. International organized crime in its highest form is far removed from the streets. These groups are highly sophisticated, have billions of dollars at their disposal, are highly educated, and employ some of the world’s best accountants, lawyers, bankers and lobbyists. They go to great lengths to portray themselves as legitimate businessmen and even advocates/benefactors for the local populace and others.” 13 Just as the global economy was descending into recession and indebted consumers were under pressure, non economic forces sent the price of oil skyward. Immediately after the spike in oil prices, the indebted consumer collapsed. 14 The Oil Price versus U.S. Retail Sales (QoQ Change) 15 No matter the administration, Justice will not act to protect us. Thanks to the GOP, the CFTC has no money to protect us. 16 Gary Gensler, CFTC Chairman The nation cannot be assured this agency can closely monitor for the protection of customer funds and utilize our enforcement arm to its fullest potential to go after bad actors in the futures and swaps markets. Testimony of Chairman Gary Gensler Before the US Senate Committee On Agriculture, Nutrition & Forestry, Washington, DC February 27, 2013 17 Part II: Can There Be Another Credit Bubble? 18 The ratio of private debt to GDP has come down, but only by a small amount. It remains very high. The U.S. household debt to GDP ratio is one of the highest in an indebted world. Contrary to common wisdom, corporations are highly indebted. Based on U.S. history and global comparisons any significant increase in this ratio should prove dangerous. 19 Andrew Smithers, Smithers & Co. 20 There are many ways of measuring corporate debt. What follows are several calculations. Corporate debt is high relative to U.S. history. Global corporate debt is high. The U.S. level is in the middle of the global range. 21 Relative To A Europe In Crisis, U.S. Households Are Highly Indebted. McKinsey & Company. January 2012 22 Non-Financial Corporate Debt To GDP 23 24 Nouriel Roubini is more concerned about a credit bubble than I am. He argues that risky corporate debt is already on the rise. Existing financial fragility holds the Fed hostage. As a result, the Fed will move too slowly. There will be a 2-3 year credit bubble that will end in tears. I respect his argument. 25 Nouriel: The Fed Will Respond Too Slowly Well this time around, like last time around, the unemployment rate is very high. Actually higher than the previous cycle. Growth is even more anemic. And on top of it right now you have high levels of private and public debt so if the Fed made a mistake and exited too slowly in 2004 and took them two years to normalize the interest rate, the fed funds, so this time around their gonna go even more slowly because the economy is weaker, unemployment is higher and high interest rates are gonna kill the bond market and going to increase the debt burdens for the private and public sectors so they will be forced to exit even more slowly and if last time around we had a bubble this time around we’re gonna have a bubble for longer than otherwise. Roubini Says Austerity Backlash Big Economic Risk Bloomberg TV Interview with Mark Burton March 8, 2013 26 Nouriel: So We Will Repeat The Last Cycle So the beginning of the asset bubble has already been seen in credit markets in the United States high yield payment in kind covenant light is now spreading to emerging markets to commodities to U.S. and global equities. I wouldn’t call it yet a bubble but another 2 or 3 years of very easy money of additional quantitative easing and very slow exits from zero policy rates could be the repeat of the cycle that led first to the bubble in 2004 and 2006 and eventually to the crash of 2006 and 2008. So that is going to be the scenario. Probably a repeat of what we have seen. Roubini Says Austerity Backlash Big Economic Risk Bloomberg TV Interview with Mark Burton March 8, 2013 27 Nouriel: Macro Pru Regulation Won’t Be Enough Now the Fed is saying we’re going to use the interest rate to stabilize inflation and growth and we’re going to use macro prudential regulation of the credit system as a way of controlling the asset bubble but the recent critique by Jeremy Stein of the Fed board that said that the interest rate policy tool is the only one that can go in all the cracks and using macro prudential regulation is not going to do the job because when you have too much liquidity and you control one part of the credit market and liquidity is gonna go to another part is a valid critique so macro pru is not going to do the job, interest (rate) is going to rise very slowly and going to create another huge credit bubble ... asset bubble and is going to end up, eventually a couple of years from now, in tears. Roubini Says Austerity Backlash Big Economic Risk Bloomberg TV Interview with Mark Burton March 8, 2013 28 Part III: Keynes: The Irrational Casino Stock Market 29 I have heard Jeremy Grantham (GMO) say to Charlie Rose that Keynes’ chapter 12 of the General Theory was the greatest piece ever written on the stock market. And that all of economics and finance has yet to catch up with Keynes. For a little less than 20 years Keynes was an incredibly aggressive leveraged speculator in all markets including stocks, and he was amazingly successful.
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